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Bank Grapples With CDOs in Light of Volcker Rule

Zions Bancorporation, the nation's largest holder of bank-issued trust-preferred CDOs, must reduce portfolio by about $387 million because of newly finalized Volcker Rule.

Zions Bancorporation, Utah’s biggest lender, said the new Volcker Rule forces the company to get rid of some prohibited holdings at a cost of about $387 million.

The bank can no longer keep trust-preferred collateralized debt obligations (CDOs) issued by banks and insurers until they mature, the Salt Lake City-based firm said today in a statement. Other asset-backed CDOs are included in the non-cash charge, which Zions said may be bigger or smaller depending on how sales mandated by the Volcker Rule affect prices.

The cost is more than Zions earned for any calendar year since 2007, marring the turnaround engineered by Chief Executive Officer Harris Simmons. The bank has posted two profitable years after three straight losses starting in 2008 that were driven by soured real estate loans and charges tied to CDOs. The disclosure by Zions spurred speculation of similar writedowns at U.S. banks.

Zions stands out among regional lenders for the size of its CDO portfolio because “most banks just didn’t choose to make these types of investments,” Brad Milsaps, an analyst at Sandler O’Neill & Partners LP, said in an interview. “It wouldn’t surprise me if other banks make similar disclosures, but it would be on a much smaller relative scale.”

The non-cash impairment charge will reduce fourth-quarter and full-year results, and Zions plans to update investors within the first 10 days of January, Chief Financial Officer Doyle Arnold told analysts during a conference call. Zions advanced 0.3 percent to $28.56 at 4 p.m. in New York trading. The stock gained more than 33 percent this year, beating the 24-company KBW Bank Index’s 31 percent.

The Volcker Rule, approved by regulators last week, is designed to keep banks from making risky trading bets with their own money that might cause them to collapse. It’s named after Paul Volcker, the former Federal Reserve chairman who pushed for the ban, and it was included in the 2010 Dodd-Frank Act.

The final version of the rule emerged after three years of drafting by regulators and lobbying by banks trying to soften the impact, spanning almost 1,000 pages.

“This is not something that we had anticipated, nor do we think we reasonably could have anticipated based on what was on the proposed rule,” Arnold said.

CDO Gorilla

Zions owned $1.23 billion of bank-issued trust-preferred CDOs as of Sept. 30, the most among all U.S. banks, according to analysts at Sterne Agee & Leach Inc. About 3 percent of U.S. banks held similar CDOs, and a sudden sale by Zions could roil the market, Sterne Agee said.

“They are the 800-pound gorilla in this space,” Sterne Agee’s Matt Kelley said in an interview. “They have a lot at stake and they have an incentive not to tip their hand.”

The assets must be divested by July 21, 2015, unless regulators grant a two-year extension, Zions said.

“We’re not going to just go out and dump those things tomorrow,” Arnold said. “We’ll be exploring a variety of ways to come into compliance with the Volcker Rule, not all of which may involve the sale in the market.”

All banks may not interpret the Volcker Rule the same way, according to Jason Goldberg, an analyst at Barclays Plc.

“There’s a lot of pages,” Goldberg said in an interview. “It’s going to take some time to figure this all out.”

The impairment reduces the weighted average amortized cost of the securities to about 51 percent of their face value, according to Zions. The estimated impact was based on conditions as of Sept. 30, and the bank said prices for the securities had improved since then.

As a result of the accounting adjustments, the bank’s common equity Tier 1 ratio as of Sept. 30 decreased to about 9.74 percent from 10.47 percent using Basel I calculations, the company said. The securities have been a drag on Zions at least since 2008, when the company disclosed that $1.5 billion of bank and insurance trust-preferred CDO securities would be held to maturity instead of being tagged as available for sale—the opposite of today’s maneuver. The bank went into the financial crisis with “too many CDOs,” W. David Hemingway, executive vice president of capital markets and investments, said during a November conference call.

CDO Expenses

Zions reported impairment and valuation losses throughout 2009, including $283.1 million in the first quarter alone, according to a company statement. In 2010, the bank persuaded Deutsche Bank AG to assume the credit risk of a portfolio of CDOs with a notional value of $1.16 billion, with an estimated cost of $35 million to Zions in the first year.

“Zions’s inability to deal with the negative capital implications of this Trups CDO portfolio over the last several years apparently continues, with Volcker hammering another nail here,” said Michael Shemi, a director at Christofferson, Robb & Co., a New York-based hedge-fund firm. “That original 2010 Deutsche Bank-Zion deal to hedge the portfolio seems to have led to further regulations.”

Under the Volcker rule and the bank’s own rewritten guidelines, Zions would give a lot more scrutiny before buying any more structured securities, Arnold said. “We haven’t bought any CDOs really since almost pre-crisis probably, and certainly wouldn’t touch them today,” he said.

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